Contagion: Home Capital Bank Run Spreads To Another Canadian Mortgage Lender

As discussed first thing this morning, the fate of Canada's largest alternative mortgage lender, Home Capital Group, appears to have been decided over the weekend, when in the span of just one week, over 70% of the company's deposit base had been withdrawn, effectively mothballing the business, leaving just a sale or liquidation as the two possible outcomes even as a $2 billion emergency line of credit keeps the company afloat, at least until HCG's $12.8 billion in GICS mature some time over the next 30 to 60 days.

Predictably, the news of the ongoing bank run once again spooked shareholders, who sent its stock sliding by 10%, and wiping out two-thirds of the company's market cap in under 2 weeks.

A bigger red flag emerged when concerns about possible contagion appeared to have been justified Canada's Equitable Group, another alternative mortgage lender, said Monday it had started seeing “an elevated but manageable” decrease in deposit balances, traditionally a polite way by management to admit a bank jog is taking place. The company said that customers had withdrawn an average C$75 million each day between Wednesday and Friday, and while the withdrawals so far are modest, and represented 2.4% of the total deposit base, the recent HCG case study showed how quickly such a bank run could escalate. And while liquid assets remained at roughly C$1 billion after the outflows, the company also announced that it had taken out its own C$2 billion credit line with a group of Canadian banks, just in case the bank run was only getting started.

Having taken preemptive action, Equitable’s loans terms were more favorable than Home Capital’s, which as reported last week is paying an effective rate of 22.5% on the first half of the C$2 billion credit line that it tapped Monday from the Healthcare of Ontario Pension Plan.

According to Bloomberg, Equitable is paying a far more modest 1.25% interest rate on the drawn portion, and a 0.75% commitment fee and a 0.5% standby charge.

Trying to mitigate concerns, Andrew Moor, CEO of Equitable said that “the issues affecting the well-known trust company in Toronto are their issues alone, and it’s unfortunate the banking industry has been dragged into it." He spoke on a call to discuss earnings, which were published almost two weeks earlier than planned due to the Home Capital selloff.

To be sure, looking at historical credit losses, Equitable would be deemed quite safe, barely ever having seen any, which in retrospect may be troubling: another company which is in the same boat is none other than Home Capital Group.

Following news of the Equitable loan, a relief rally sent shares of the lender soaring by 26% to C$46 in Toronto, helping recoup some of the 41% drop from last week. Other Canadian bank stocks that had fallen last week also recovered Monday. First National Financial Corp., a mortgage lender, jumped 2 percent. Bloomberg notes.

So while Canada's nervous investors, not to mention its regulators, exhaled a breath of relief today hoping that things are back to normal even as they continue to keep a close watch on Equitable and other alt-lenders to see if the panic has subsided, attention turned to Home Capital's bonds. Bloomberg reports that Home Capital’s bonds maturing in December next year were trading little changed at 90.6 cents on the dollar on Monday, according to Bloomberg data, yielding about 10 percent, compared with less than 3 percent on April 19. Home Capital also has C$325 million in 2.35 percent bonds maturing on May 24.

“Things are perhaps all right from the bondholder’s perspective, but not certain and the bonds reflect that,” said Mark Carpani, a portfolio manager at Ridgewood Capital Asset Management, with C$1.1 billion in assets. He said he doesn’t hold any Home Capital bonds and declined to comment at what level he’d consider buying them.

While an optimistic outlook may be warranted, the biggest risk as explained this morning, remains with HCG's C$12.8 billion in GIC deposits which are essential to fund its mortgage business, and which represents 1 percent of the Canadian mortgage market. Withdrawals could accelerate as these short-term deposits mature.

What is the worst case scenario? Declining deposits could lead to a windup of the company, which would be monitored by the federal bank regulator, the Office of the Superintendent of Financial Institutions, according to Bloomberg. The lender said Thursday it has hired BMO Capital Markets and RBC Capital Markets to conduct a review of strategic options, signaling that a sale may be on the table.

“OSFI maintains ongoing relationships with the financial institutions it supervises,” Annik Faucher, an OSFI spokeswoman, said by email. “While we are prevented by law from discussing the affairs of the individual financial institutions we regulate, or our ongoing supervisory work, I can confirm that OSFI is continuing to monitor the situation closely.”

Concern about the viability of HCG has extended to the Canadian government itself, with Finance Minister Bill Morneau saying in a statement that he has been monitoring the Home Capital situation “very closely."

“I was pleased to see Home Capital’s funding issues resolved by market participants,’’ Morneau was quoted as saying. “What I’ve seen over the last few days is proof the system is working as it should, where institutions facing challenges find market-based solutions.”

Actually, the funding issues are anything but resolved, as the next 30-60 days may reveal.

However, it is perhaps the hint of a government backstop that prompted Home Capital’s biggest investor to announce he is sticking with the company, adding to its position. Toronto-based Turtle Creek Asset Management Inc., which owned 14% of Home Capital as of the end of February, praised the lender for its low loss rate and underwriting practices.

“To be clear, we have not sold shares; indeed, the opposite is the case," according to an investor letter, signed by Chief Executive Officer Andrew Brenton, managing partner Jeffrey Cole, and managing partner Jeffrey Hebel. “We are obviously not happy with recent developments at Home Capital, but we remain focused on long-term value creation for you, our fellow investors.”

Well, as long as the "fellow investors" are fine with the short-term value destruction, all should be well. Ironically, for investors like Brenton, the "best" possible outcome would be the worst one, or runaway contagion and bank runs, which would force the government to step in and do what the US government did nearly a decade ago: bail out not only Canada's housing market, but also its insolvent mortgage lenders, as well as any other banks and financial institutions that would be slammed by the bursting of Canada's housing bubble.

[...Amid the current bubble, the panelists disagreed on who to blame. “I would lay this whole problem at the feet of the government,” said Avery. “The government is coach, referee, cheerleader and fan in the housing market.” Avery argued that Toronto has been doomed for a housing crisis ever since Ontario created the world’s largest greenbelt, a near two million-acre area where development is forever prohibited, shrinking the supply of homes....]

I've explained before why the most dangerous Canadian real estate bubble is concentrated in those downtown glass-tower shoebox highrise apartments that are being pushed hard by local developers and the municipal "green" crowd, rife with corruption and speculation. You see thousands upon thousands of new units under construction, more than a Chinese factory town. When crunch time hits, those things will be money pits.

It is also possible the world will have a debt jubilee and just wipe out all debt and gold could go to $30/ounce too. Unlikely, but it is a possibility as well this point in the game. The world has written off debt many many times in history.

The administrative or accounting side maybe but when you think of the root cause was completely avoidable. The analogy I like to use is a house built on sand. Infrastructure cost to sustain a speculative asset that historically has been a protected given right has never been proven to be sustainable nor has it's effects on an economy over all. Experiment started in the 80's as tax cuts and deregulation leading to a band aid solution to fix that mess called forward guidance. All they had to do is leave it alone plus become self sufficient on the energy side. The deregulation gave money lenders a green light to saturate the market with overvalued products then soak the consumer on the down side. The finishing touch was lowering rates to force investors into a house built on sand. To make a complex story short we gave into removing a couple of auto stops. I guess the 80's and 90's were good times. Folks tend to let their guard down when things look good. They used to call that trust or faith in the system. The house always wins in the end.

Well, the TCH alone is nearly 5,000 miles long. Nobody's got that many tanks.

p.s. Canada has enough AFVs for one every 230 miles of road. Assuming they are all serviceable. A rough back-of-the-envelope calculation tells me the nearest AFV to my house would be 35 km away, and will affect my life not a whit.

If they distribute the tanks by population, then there won't even be one in my Province.